This is a timely thread about which I am still am somewhat confused myself. Perhaps some of our more experienced members can comment with illustrative specifics or point to a good resource on the subject (i.e. tax efficient allocation/rebalancing).
AV8 said:
The simple way for me to rebalance our AA without incurring a taxable event would be to reallocate within my and DWs Roth IRAs and my TSP (401k).
The end result would be that a high percentage of the more volatile portion of our AA (Intl, Small-cap, Mid-Cap) would be in the IRAs and TSP (401k).
Seems that the Roth is a good place to hold the accounts within which you expect to realize
the greatest net gains (compared with taxable account) for the anticipated holding period,
not just the highest rate gains. So, while the traditional advice on holding income funds in Roth may indeed produce the greatest percentage savings based on tax rates for income versus cap gains, for example, over a long holding period one could very easily realize sufficiently greater capital gains in one of those volatile classes you refer to to more than offest the better tax rate savings gained from income funds (i.e. while a lower potential cap gains tax rate may be involved, there may also be sufficiently greater gains to make the Roth the long term winner). So, I don't see any problem with holding asset classes with high potential for long term cap gains growth in the Roth, assuming you're not holding significant and less tax efficient assets in taxable accounts.
One simple tip from other threads that can help with tax efficient rebalancing in taxable accounts is to have all dividends and realized gains redirected into a money market fund, from which one can then make deposits to underweighted asset clasees without selling shares of the originating funds (as might need to be the case if the dividends/gains were auto-reinvested into the originating funds).
AV8 said:
If I understand correctly, the thing to consider would be future tax liability of fund positions in the withdrawal phase of RE, not necessarily during the growth phase. Correct?
Seems that tax consequences at deposit, withdrawal *and* within the account during accumulation/growth all are factors. For example, an active MF account that realizes significant dividends and capital gains would hands down do much better in a Roth than in either the 401K or taxable account, due to tax free accumulation and withdrawal. This is once the money is committed, but there may also be considerations going in as to whether the tax deferral of 401K is better than the after tax deposit (but tax free growth/withdrawal) of Roth.
The same fund in a 401K, on the other hand, would benefit from tax free compounding during accumulation/growth, but at withdrawal, gains that would have been taxed along the way at dividend or cap gains rates are instead taxed at income rates (which may very likely be higher). Also, however, a larger amount of money would have been compounding along the way due to the tax deferral (compared with taxable account).
Personally, I'm still a bit confused on the fine points, but fortunately we have been in a postion to fund Roth, 403B and taxable accounts - tax diversification as Updegrave calls it. Most holdings in all three are equity mutual funds. So for tax efficiency considerations what we we do is
1) try to hold index funds or other tax efficient funds in taxable accounts,
2) redirect dividends and cap gains in taxable accounts to money market for subsequent purchases into underweighted classes at the time,
3) hold funds that produce higher income/turnover/gains in tax deferred accounts (Roth and 403B), as well as some of the higher volatility funds regardless of income characteristics,
4) distribute new 403B money (DCA) and annual Roth deposits into underweighted classes at the time (this is facilitated by holding some of the same funds in both Roth and 403B)
Not sure if this helpful for anyone. Sorry for the ramble, but I'm also be interested in hearing the thoughts of others on any finer points we might be missing.